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The Indian Financial
System: An Introduction
Introduction





Financial system intermideates between
the flow of funds belonging to those who
save a part of their ...
Indian Financial System
Indian Financial System

Formal / Organized
Financial System

Informal / Unorganized
Financial Sys...
Indian Financial System

Formal Financial
System

Regulators
MoF
SEBI
RBI
IRDA

Components
1. Financial
Institutions
2. Fi...
Pros and Cons of Informal
Financial System


Advantages :
◦ Low transaction cost
◦ Minimum default risk
◦ Transparency of...
Financial Institutions
They are the intermediaries that
mobilize savings and facilitates the
allocation of funds in effici...


Banking & Non-banking

◦ Banking : Creators and purveyors of credit
◦ Non-banking : Only purveyors. E.g.. DFIs,
NBFCs

...
Financial Market


Types
◦ Money Market






Treasury Bills
Call Money Market
Notice Money Market
Commercial Papers...
Types
Capital Market

Equity
Market

Primary
Market

Money Market

Debt
Market

Secondary
Market

Derivatives
Market

Trea...
Money Market






It is market for short term debt
instruments.
A highly liquid market.
E.g. Call money market, certi...
Capital Market
It is a market for long-term securities like
equity or debt.
 Functions :


◦ Mobilize long term savings ...
Link Between Capital Market
and Money Market






Often, financial institutions actively
involved in the capital marke...
Primary Market and Secondary
Market
The primary market creates long-term
instruments for borrowings.
 The secondary marke...
Link between Primary Market
and Secondary Market
A buoyant secondary market is
indispensable for the presence of a
vibrant...
Financial Instruments






A financial instrument is a claim against
a person or an institution for payment, at
a futu...
Financial Instruments

Term :
Short
Medium
Long

Type

Primary / Direct
Securities

Equity
Preference
Debts and Various
Co...
Financial Services


Categories of financial services:
◦
◦
◦
◦
◦



Funds intermediation
Payment mechanism
Provision of ...
Interaction among Financial
System Components
Interdependent and interact
continuously
 Interactive
 Close link
 Compet...
Functions of Financial System
Mobilize and allocate savings
 Monitor corporate performance
 Provide payment and settleme...
Key Elements of well
functioning Financial System
Strong
legal
and
regulatory
environment
 Stable money
 A central bank
...
Financial System Design


Bank Based
◦ A few large banks play a dominant role
and the stock market is not important
◦ E.g...
Bank Based :
◦ Banks play a pivotal role in mobilizing savings,
allocation of capital, overseeing the investment
decisions...
Market Based
◦ The securities markets share centre stage with
banks in mobilizing the society’s savings for
firms, exertin...
: Review Questions :
Explain Financial System. “A financial
system is a well integrated system
whose components / parts in...
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The financial system an introduction

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The financial system an introduction

  1. 1. The Indian Financial System: An Introduction
  2. 2. Introduction    Financial system intermideates between the flow of funds belonging to those who save a part of their income and those who invest in productive assets. It mobilizes and usefully allocates scarce resources of a country. A financial system is a complex , well integrated set of sub systems of financial institutions, markets, instruments & services which facilitates the transfer and allocation of funds efficiently & effectively.
  3. 3. Indian Financial System Indian Financial System Formal / Organized Financial System Informal / Unorganized Financial System It is characterized by the presence of an organized, institutional and regulated system which caters to the financial needs of the modern spheres of economy. It is an unorganized, noninstitutional and nonregulated system dealing with traditional and rural spheres of the economy.
  4. 4. Indian Financial System Formal Financial System Regulators MoF SEBI RBI IRDA Components 1. Financial Institutions 2. Financial Markets 3. Financial Instruments 4. Financial Services Informal Financial System Individual money lenders Group of persons operating as funds Partnership firms
  5. 5. Pros and Cons of Informal Financial System  Advantages : ◦ Low transaction cost ◦ Minimum default risk ◦ Transparency of procedures  Disadvantages : ◦ Wide range of interest rates ◦ Higher rates of interest ◦ unregulated
  6. 6. Financial Institutions They are the intermediaries that mobilize savings and facilitates the allocation of funds in efficient manner.  Classification of Financial Institutions :  ◦ ◦ ◦ ◦ ◦ ◦ Banking – Non-Banking Term Finance Specialized Sectoral Investment State - Level
  7. 7.  Banking & Non-banking ◦ Banking : Creators and purveyors of credit ◦ Non-banking : Only purveyors. E.g.. DFIs, NBFCs  Term Finance ◦ IDBI, ICICI, IFCI, SIDBI, IIBI  Specialized ◦ EXIM, TFCI, ICICI Venture, IDFC, NABARD, NHB  Sectoral ◦ UTI, LIC, GIC   Investment State – Level ◦ State Financial Corporations, State Industrial Development Corporations
  8. 8. Financial Market  Types ◦ Money Market      Treasury Bills Call Money Market Notice Money Market Commercial Papers Certificate of Deposit ◦ Capital Market  Equity Market  Debt Market  Segments ◦ Primary Market ◦ Secondary Market
  9. 9. Types Capital Market Equity Market Primary Market Money Market Debt Market Secondary Market Derivatives Market Treasury Bills Call Money Market Commercial Bills Certificates of Deposits
  10. 10. Money Market     It is market for short term debt instruments. A highly liquid market. E.g. Call money market, certificates of deposits, commercial paper and treasury bills Functions : ◦ Provide a balancing mechanism to even out the demand for and supply of short-term funds ◦ Provide a focal point for central bank
  11. 11. Capital Market It is a market for long-term securities like equity or debt.  Functions :  ◦ Mobilize long term savings to finance longterm investments ◦ Enable quick valuation of financial instruments – both equity and debt ◦ Disseminate information efficiently for enabling participants to develop an informed opinion about investment, disinvestment, reinvestment or holding a particular financial asset. ◦ Provide liquidity with a mechanism enabling the investors to sell financial assets
  12. 12. Link Between Capital Market and Money Market    Often, financial institutions actively involved in the capital market are also involved in the money market Funds raised in the money market are used to provide liquidity for long-term investment and redemption of funds raised in the capital market In the development process of financial markets, the development of the money market typically precedes the development of capital market
  13. 13. Primary Market and Secondary Market The primary market creates long-term instruments for borrowings.  The secondary market provides liquidity through the marketability of these instruments.  ◦ It is also known as stock market.
  14. 14. Link between Primary Market and Secondary Market A buoyant secondary market is indispensable for the presence of a vibrant primary capital market  The secondary market provides a basis for the determination of prices of new issues.  Depth of the secondary market depends on the primary market  Bunching of new issues affects prices in the secondary market. 
  15. 15. Financial Instruments    A financial instrument is a claim against a person or an institution for payment, at a future date, of a sum of money and/or a periodic payment in the form of interest or dividend. Many financial instruments are marketable as they are denominated in small amounts and traded in organized markets. Distinct Features of financial instruments: ◦ Marketable ◦ Tradable ◦ Tailor made
  16. 16. Financial Instruments Term : Short Medium Long Type Primary / Direct Securities Equity Preference Debts and Various Combinations Secondary / Indirect Securities Time Deposits MF Units Insurance Policies
  17. 17. Financial Services  Categories of financial services: ◦ ◦ ◦ ◦ ◦  Funds intermediation Payment mechanism Provision of liquidity Risk management Financial engineering – E.g. off-balance sheet items, development of synthetic securities Need for financial services: ◦ ◦ ◦ ◦ Borrowing and Funding Lending and investing Buying and selling securities Payments and settlements
  18. 18. Interaction among Financial System Components Interdependent and interact continuously  Interactive  Close link  Competing with each other 
  19. 19. Functions of Financial System Mobilize and allocate savings  Monitor corporate performance  Provide payment and settlement system,  Optimum allocation of risk – bearing and reduction  Disseminate price-related information  Portfolio adjustment facility 
  20. 20. Key Elements of well functioning Financial System Strong legal and regulatory environment  Stable money  A central bank  A sound banking system  An information system  A well functioning security market 
  21. 21. Financial System Design  Bank Based ◦ A few large banks play a dominant role and the stock market is not important ◦ E.g. Germany, India  Market Based ◦ Financial markets play an important role whole the banking industry is much less concentrated ◦ US, UK
  22. 22. Bank Based : ◦ Banks play a pivotal role in mobilizing savings, allocation of capital, overseeing the investment decisions of corporate managers and providing risk management facilities ◦ It is tend to be stronger in countries where governments have a direct hand in industrial development.  Advantages: ◦ Close relationship with parties ◦ Provides tailor-made contracts ◦ No free-rider problem  Disadvantages : ◦ Retards innovation and growth ◦ Impedes competition
  23. 23. Market Based ◦ The securities markets share centre stage with banks in mobilizing the society’s savings for firms, exerting corporate control and easing risk management  Advantages : ◦ Provides attractive terms to both investors and borrowers ◦ Facilitates diversification ◦ Allows risk sharing ◦ Allows financing of new technologies  Disadvantages : ◦ Prone to instability ◦ Exposure to market risk ◦ Free-rider problem
  24. 24. : Review Questions : Explain Financial System. “A financial system is a well integrated system whose components / parts interact with each other” Explain. 2. Explain the functions and key elements of well functioning financial system. 3. Explain the types of various financial markets and their inter-relationship. 4. “A market-based financial system is preferable over a bank-based system”. Explain and Comment Critically. 1.

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